Will Toll Brothers' Big Deal With GTIS Partners Accelerate Growth?

Luxury homebuilder Toll Brothers  (NYSE: TOL  ) and privately held GTIS Partners have acquired 3,700 acres of prime real estate near Houston, stating that the property could net up to "$2.6 billion in home sales in aggregate," once the project is complete. Considering that Toll Brothers did just under $2.7 billion in total sales over the past 12 months, this looks like a massive source of future growth. However, just a little digging shows that the deal isn't as lucrative as it seems. 

How much upside does it offer Toll Brothers? Does this make the company a better investment today than peers like Meritage Homes  (NYSE: MTH  ) and NVR Inc. (NYSE: NVR  ) ? Let's take a closer look.

The fine print
While this project is expected to generate 6,500 new homes and $2.6 billion in sales, missing out on one critical detail drastically alters the value to Toll Brothers. From the release (emphasis mine):

 ...the Toll-GTIS joint venture expects to develop approximately 6,500 single-family home lots which will be sold to local, regional and national home builders over the anticipated life of the community. Toll Brothers may acquire up to 1,750 of those lots for its own home building operation over that time period. When fully built out, it is anticipated that Sienna South will have generated gross home sales of over $2.6 billion. 

Water park at Sienna Plantation. Source: Toll Brothers

Toll Brothers will only build about one-quarter of this development. With a little quick and dirty math, the average home will net an average sale price of $400,000. For Toll Brothers, this would be around $700 million in sales -- not a small number, but a far cry from $2.6 billion. However, Toll Brothers won't be building "average" houses here, and will likely net a higher average sale price. Additionally, the company may also share in the profits from selling parcels to other homebuilders, but that's speculation as the details of the deal aren't public. 

Housing still strong, will remain strong in 2014 and 2015
While this deal isn't as huge as it looks on the surface, at least $700 million in future sales lined up is great news for Toll Brothers investors. It's also a reminder that the national housing market continues to improve.

Existing home sales and new construction both continue to improve, with the latest 2013 numbers showing the best year existing home sales since 2006. New home construction starts increased almost 10% in 2013; the highest levels since 2007, even with softness in November and December, partly due to extreme weather in the Northeast. 

Master suite of Sandhaven floor plan at Sienna Plantation. Source: Toll Brothers

The outlook continues to be positive, if a little muted. The Mortgage Bankers Association recently revised its 2014 mortgage projections for home purchases down 5%, from $711 billion to $677 billion. However, even after the downward revisions, the projection is for a $25 billion increase in mortgages for home purchases from 2013. 2015 is projected even stronger, with purchase mortgages to increase a whopping $119 billion, to nearly $800 billion in total even as interest rates will approach and break 5% this year. 

NVR and Meritage Homes worth a look
NVR is actually made up of four different builders: NVHomes, Ryan Homes, Fox Ridge, and Heartland Homes, and its separate financing business, NVR Mortgage which offers financing to customers of all four homebuilder brands. What makes NVR attractive is how incredibly well management has returned value to investors, primarily through a long-term stock buyback program that has reduced shares outstanding by 30% over the past decade, even as the company has grown its market cap by 49%. This has led to a 115% return for investors -- better than the market over the same period of time:

NVR Shares Outstanding Chart

NVR Shares Outstanding data by YCharts

While net income is well down from the more than $700 million earned at the peak of the housing boom, NVR managed to make money even during the depths of the financial crisis:

NVR Net Income (TTM) Chart

NVR Net Income (TTM) data by YCharts

For long-term investors, this recipe of financial strength and shareholder-friendly behavior is worth a closer look. 

Meritage Homes is by far the smallest of the three, and like Toll Brothers, suffered heavy losses during the recession. However, it now generates impressive earnings off much lower revenues than the other two, and carries significant growth potential in its key markets of Southern California, the Southwest, and Southeast. Preliminary results for the fourth quarter indicate that the company will continue driving impressive earnings results, with margin levels increasing 400 basis points versus 2012's fourth quarter. 

The bad news? Meritage also announced a public offering of 2.2 million shares, diluting existing investors by 6% overnight. While troubling on the surface, this will net the company $96 million in working capital, which will help accelerate growth. 

Money is historically cheap; housing continues to rebound
Housing is a cyclical business, and it's best to invest on the upswing. After the bust in 2009, the environment has continued to improve every year. Even with the Fed's tapering expected to move mortgage rates higher, they remain historically low, and will for the next few years. From a valuation perspective, NVR and Toll Brothers (after taking a big hit to net income this year) are expensive on a P/E basis, at 21 and 38, respectively, while Meritage remains near 10, belying its growth potential. However, the long-term story on housing, and the sound execution of all three companies makes them worth consideration.

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